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The following article is excerpted from the Center for Health Transformation’s excellent new book Stop Paying the Crooks: Solutions to End the Fraud that Threatens Your Healthcare www.healthtransformation.net. As the book reveals—and as Merrill Matthews and Meredith Matthews note in our excerpt below—fighting health care fraud is an enormous opportunity to lower health care costs for health insurance consumers. Yet most of the health care reform plans proposed so far do not make fighting fraud a priority. In fact, the central element of the plans touted by President Barack Obama runs the risk of increasing health care fraud. President Obama wants to create yet another government-funded health insurance program. The so-called “public option,” he says, will keep the private sector in check and find new efficiencies. Yet government programs such as Medicare and Medicaid are more vulnerable to fraud than is private health insurance. The President has the issue backwards: Before government health insurance is expanded, the government needs to take cues from the private sector on how to fight fraud. —Editor

THE NATIONAL DEBATE OVER HEALTH CARE REFORM has, once again, focused the country’s attention on efficiency. How can we create a more efficient—which means both less expensive and of higher quality—health care system?

One group of reformers thinks the answer is easy: Expand Medicare—the federal health insurance program for seniors—or create a program similar to Medicare to cover most or all Americans. This group of reformers believes Medicare is the most efficient health insurance program in the country, maybe even the world, and they think it makes sense to provide a Medicare-like option for everyone (though others think the “option” part would be temporary because the government would soon require people to join).

The problem with this argument is that it simply is not true. Medicare looks efficient only because it hides most of its administrative costs. Perhaps more important, because Medicare does not engage in the due diligence that private sector insurers do, it is rife with fraud, costing taxpayers billions of dollars every year.

Before Medicare becomes a model for anything—except how not to run a health care system—policymakers should look at how the private sector manages claims and limits fraud. In short, before the government starts dumping more Americans into the financially collapsing Medicare system, it needs to demonstrate that Medicare has learned how to control costs and improve both quality and efficiency in the same way the market does—by satisfying both buyers and sellers.

Medicare’s Hidden Administrative Costs

One of the most common and least challenged assertions in the health reform debate is that Medicare’s administrative costs are about 2 percent to 3 percent of claims costs, while private insurance companies’ administrative costs fall in the range of 20 percent to 25 percent.

It is very difficult to do a real apples-to-apples comparison between Medicare’s true costs and those of the private insurance industry. The primary problem is that private sector insurers must track and divulge all their administrative costs, including rent, taxes, management, start-up costs, claims processing, profit, and so on. Not Medicare. What the government considers Medicare’s administrative costs are simply what it costs to process the reimbursement checks.

Most of Medicare’s other administrative costs are hidden in other parts of the federal budget or are completely ignored by the complex and bureaucratic reporting and tracking systems used by the government. For example, the Department of Health and Human Services Office of Inspector General claims that 80 percent of its resources and 1,500 employees are dedicated to protecting Medicare, Medicaid, and their beneficiaries from fraud and abuse. Those costs are not captured in Medicare’s administrative costs, while private sector claims adjudication and anti-fraud efforts are.

In an effort to identify and estimate Medicare’s true administrative costs, the Council for Affordable Health Insurance contracted with actuarial firm Milliman to publish “Medicare’s Hidden Administrative Costs: A Comparison of Medicare and the Private Sector.” After going through the federal budget and identifying those hidden costs in Medicare, the study found that actual administrative costs are 5.2 percent. But that is not all. Because this estimate is a ratio—i.e., total claims paid divided by the cost to pay them—and because of its higher cost per beneficiary, Medicare administrative costs appear lower than they really are. If the numbers were adequately “handicapped” for comparison with the private sector, they would be in the 6 percent to 8 percent range.

So what does the private sector pay in administrative costs? About 8.9 percent, with large companies that reach economies of scale falling at around 8 percent. While it appears that Medicare may have slightly lower administrative costs than the private sector, those additional costs are not “wasted money” that could go toward insuring the uninsured, as private sector critics like to claim. Those additional dollars keep premiums lower by more closely scrutinizing claims. It would be hard to make the same case for Medicare.

Medicare’s Rampant Fraud

You know there is a problem when the Russian mob finds scamming a U.S. federal health insurance program easier and more lucrative than, say, running drugs or owning casinos.

According to a 2006 article in the Los Angeles Daily News, court documents in one Medicare fraud case said: “The case is connected to Russian-Armenian organized crime that gutted Medicare of more than $20 million using a network of clinics, paid kickbacks to marketers for patient referrals and billed Medicare for tests that were unnecessary or went undelivered.”

And the Philadelphia Daily News reported that the FBI’s organized crime squad’s investigation of a different Russian group operating a hospice scam, a growing area of fraudulent activities, involved some $8.5 million.

In 2007, several Nigerians were sentenced to prison terms, along with extensive fines, for their part in swindling Medicare. The federal judge in the case said of one culprit: “After being welcomed as a guest in this country, the defendant plundered the Medicare program in an outrageously bold and rapacious health care fraud scheme.”

The scammer had apparently billed for 423 wheelchairs, for which he received about $4,000 each from Medicare. He then either did not provide seniors with the wheelchairs or gave them chairs of lesser quality. It would be nice to say that these are isolated incidents, but they are not. Those who follow such stories will find accounts of new arrests, stings, and convictions an almost daily occurrence in the newspapers. How extensive is the fraud? No one knows for sure. But there are estimates.

Attorney General Eric Holder announced recently that the government would be ramping up its efforts to fight Medicare and Medicaid fraud, estimated at $60 billion a year at least. That is out of a program that costs $460 billion per year. Ponzi schemer Bernard Madoff defrauded people out of some $50 billion, and the public and media went (justifiably) berserk. Medicare has $60 billion of waste and fraud each year, and the president and the Democratic leadership in Congress want to make it a health insurance model for the country.

Fortunately, both the federal government and the states have stepped up their anti-fraud efforts in the past several years. Government officials have exposed widespread and rampant fraud and have moved to shut the criminals down, prosecute them, and recoup some of the money lost. Yet government assessments of those anti-fraud efforts have discovered some internal problems, exposing just how easy it is to commit Medicare and Medicaid fraud.

For example, in 2006, Medicare officials claimed they had dramatically reduced fraud in the program. But a subsequent 2008 analysis by the federal inspector general’s office found that Medicare had missed more than a third of the fraudulent spending on durable medical equipment (DME) such as wheelchairs and oxygen supplies—about $2.8 billion in improper spending. In addition, Government Accountability Office investigators set up fictitious companies and were able to get the Centers for Medicare & Medicaid Services (CMS), with some effort, to give the fake companies billing privileges.

While the government has successfully recovered some of the billions of dollars in Medicare and Medicaid fraud, this represents only a fraction. Like the Madoff investment scandal, much of the money is gone by the time arrests are made. The criminals can be fined, jailed, and forced to pay restitution, but if they have spent most of the money, it will never be recovered.

Who Is Better at Catching Fraud?

Those pushing for a bigger government role in health care often criticize private sector insurers for their efforts to manage and adjudicate claims. As a presidential candidate, Hillary Clinton complained that insurers spend billions of dollars a year denying claims. She argued that they should use that money instead to just pay the claims. It was a breathtakingly naive statement from one who should know better. Medicare does “just pay the claims,” but the resulting fraud costs taxpayers billions of dollars a year.

Private sector companies, by contrast, aggressively monitor claims. While that is true for any type of insurance, it is also true in other sectors of the financial industry. In recent testimony before the Senate, health policy expert James Frogue of the Center for Health Transformation noted: “The American credit card industry involves over $2 trillion in transactions per year, which is nearly the size of the health care sector. There are more than 700 million credit cards in circulation, millions of vendors, and countless items that can be purchased with a credit card. Yet total card fraud is a fraction of 1 percent.”

Actually, that figure is not far from the private health insurance sector’s record. Estimates say that claims fraud in private health insurance falls at around 1.5 percent or less. Of course, there is a cost for monitoring those claims, which represent roughly 3.3 percent of claims paid. But claims processing will not go away under government-run health insurance. That is the 2 percent to 3 percent figure now used for Medicare’s administrative cost. The private sector does spend more money than Medicare adjudicating claims. Indeed, the scrutiny is so close that health care providers frequently complain about the difficultly they have in getting legitimate claims approved and paid. But properly adjudicating claims is money well spent on the front end because it saves billions of dollars in fraudulent claims on the back end. The National Health Care Anti-Fraud Association says that every $2 million invested in fighting fraud produces returns of $17.3 million in recoveries and court-ordered judgments; plus there are the claims that were not paid.

As mentioned earlier, both the federal government and the states have ramped up their much-needed anti-fraud efforts. But these would be much more cost-effective if Medicare and Medicaid were to identify and adopt practices to monitor claims proactively on the front end. Such efforts could dramatically reduce fraudulent claims in the first place. In other words, instead of making the Medicare claims-paying structure the model for private insurers, Medicare should be learning from the private sector.

Private Insurers Check the Claims

When an insurer receives a claim from a doctor or a hospital, the claim is first entered into the computer system. The system performs several routine checks to prevent ineligible claims from being paid, including:

Has the insurer received the same claim from the same medical provider?

Do the diagnosis and treatment match?

Is the medical provider being investigated for other suspicious claims?

Is the insured person being investigated for submitting suspicious claims?

If the answer to any of these questions is yes, the insurer will investigate the claim more thoroughly. For example, if the diagnosis and treatment do not match, the insurer may contact the doctor’s office to see if there was a coding error. Or if the insurer has been notified of a pattern of suspicious claims from a provider, the insurer may hold any claims received from the provider and verify that the services were received by the patient.

Unlike with Medicare, the insurer’s investigation unit will investigate claims before they are paid. Claims are held until a determination can be made whether, in the insurer’s opinion, the claims are legitimate. In the case of a treatment and diagnosis mismatch not determined to be a coding or data-entry error, the insurer will request a review by the company’s medical director. If the claims are determined to be illegitimate and potentially fraudulent, they will be thoroughly investigated before they are denied. In most cases, the fraud unit will look outside the initial claims at all the claims submitted by the insured person and/or medical provider to determine if there is a pattern of fraud. A provider who has submitted fraudulent claims will be flagged in the system in order to ensure future claims are subjected to additional scrutiny.

Any decision can be appealed by the provider or insured person and is subject to the appeal provisions of the Employee Retirement Income Security Act (ERISA). In other words, federal law establishes specific appeal rules. If the claim is denied because the diagnosis and treatment do not match (which is not fraud), the insured person may have an additional level of external review by a doctor who is not affiliated with the insurer, doctor, or insured person.

Currently, the private sector health insurance industry spends about $616 billion a year paying traditional health care claims for those under age 65. According to a major actuarial firm, the industry spends roughly 3.3 percent, or $20 billion, a year adjudicating those claims—not “denying” them but evaluating and processing them. There does not seem to be a solid number for the amount of claim money actually denied, but several health actuaries estimate that amount to be around $3 billion—about one-half of 1 percent of total claims paid.

Scrutinizing claims closely is simply a matter of fiscal prudence. That is what consumers do every day. When we get our credit card bills, for example, most of us go down the list of items to ensure that we recognize the expenses and the amount charged. Anomalies call for closer scrutiny and even challenging an item if we think it is inappropriate. And most of us would consider foolish anyone who said he or she just paid a credit card bill without ever examining it. Well, that is Medicare’s policy.

While it is difficult to separate fraud and abuse from waste, if CMS thinks that the cost of improper Medicaid payments is around 10 percent, it is reasonable to think Medicare’s are also—roughly $45 billion a year. Add in the $33 billion from Medicaid and we are talking maybe $80 billion a year—real money even in these big-spending times.

The downturn in the economy has hurt government payroll tax revenues. That means Medicare is even more financially troubled than it was just a year ago. Helping Medicare reduce fraud on the front end would reduce the need for costly after-the-fact stings, investigations, prosecutions, and imprisonments. While efforts by the Office of Inspector General to capture criminals who commit Medicare fraud are critical to maintaining the integrity of the system—if we can use the word integrity under the current fraud-ridden program—finding ways to stop the fraud before it occurs will save taxpayers billions of dollars.

While dramatically reducing or eliminating fraud will not “save” Medicare—future costs, even legitimate ones, will still overwhelm the system—it would postpone the day of reckoning for years. Medicare costs would still increase, but from a lower number and at a slower rate. The government owes it to taxpayers to ensure that Medicare and Medicaid fraud are at an absolute minimum.

What Should Be Done?

There are no easy answers, but there are five actions Congress and CMS could take that might have a significant impact.

1. Stop the cover-up. Congress and CMS should be honest about Medicare’s true administrative costs. And fraud should be included in those costs. Private sector insurers have to include their claims-monitoring costs in their administrative totals, which, along with other expenses, increase their overall costs in relation to Medicare. Medicare should at a minimum include the Office of Inspector General’s costs, minus money recovered, and the government’s best guess at the total amount of fraud. When that is done, adding some expenses on the front end to adjudicate Medicare claims will seem reasonable.

2. Sit down with the private sector and learn what it does. Several health insurers and other specialty companies have turned claims monitoring into a science—not so they can deny claims but so they can ensure that only appropriate claims are paid. Insurance is just a pass-through mechanism; premiums have to meet health care claims, plus administrative costs and profit. If inappropriate claims are paid in the private sector, it essentially robs the pool of premium dollars and everyone has to pay more. If Medicare pays inappropriate claims, it robs taxpayers.

3. Sit down with other financial institutions. As former House Speaker Newt Gingrich regularly points out, people who have traveled to the opposite side of the world can stop at an ATM, put their bank cards in, and within 30 seconds get their money. It is fast, efficient, consumer-friendly, and nearly foolproof. Surely Medicare can learn from these private sector efficiencies.

4. Stop the attack on Medicare Advantage plans. Medicare Advantage (MA) relies on the private sector to provide comprehensive care for Medicare beneficiaries for a defined contribution. Democrats have been very critical of the program because the enabling legislation gives MA plans a roughly 13 percent increase over the amount spent on those in traditional Medicare. Regardless of what the defined contribution should be, MA plans do provide additional services for that increase, but not enough to please many members of Congress. Even so, MA plans bring the private sector’s claims scrutiny to Medicare, and Congress could learn from them.

5. Bring the consumer into Medicare. Currently, seniors on Medicare have little or no reason to be value-conscious shoppers in the health care marketplace because they are so insulated from their health care costs. The consumer-driven health care system is taking the under-65 health care sector by storm because it gives people a reason to seek value for their health care dollars. Seniors on Medicare need to be part of that movement. If we want to stop fraud on the front end, give health care consumers, including seniors, the power to control more of their health care dollars.